Research Reveals Why So Few Money Managers Beat the Market

A recent study from the University of Chicago, Carnegie Mellon, and MIT, referenced in an April article in Kiplingers, reveals great insight into why so few money managers are able to consistently beat the market.

By “consistently,” we mean over five or more years. Anything less than that doesn’t do you much good if you’re trying to develop a plan for the remainder of your working life and all the way through retirement.

And by that standard, your odds look pretty bad if you’re counting on money managers to beat the market.

Over a five-year period, Bloomberg reported that 76.5% of large-cap, 81.7% of mid-cap and 92.9% of small-cap managers underperformed their respective benchmarks. At 15 years, all three failure rates exceed 90%.

So there’s no question that active managers, by and large, fail to outperform the market. But why?

The research reveals an interesting answer that suggests a departure from analysis in favor of human nature (meaning human frailty).

Money Manager Research Parameters

Before we get to the answer, let’s be clear on the research methodology.

They studied 783 portfolios with an average size of $573 million. So these aren’t mom-and-pop money managers. These are the big boys. The study analyzed over 4.4 million trades made over a 16 year period, from 2000 to 2016.

So it includes the end of the dotcom collapse, the resulting decade of stagnation, the 2008 crash, and much of the bull market that followed.

In other words – it’s a terrific sample.

Key Finding: Great at Buying, Abysmal at Selling

The research found that money managers are great researchers – when they want to be. They research their decisions about which stocks to buy so well that, on average, money managers beat the market on their stock purchases.

That is, the equities they purchased, at the times they purchased them, outperformed the overall market.

Sounds great, right? That’s what many investors hope their money managers will do. That’s why they flock to them and entrust them with billions of dollars. And this achievement is borne from all the analysis they invest in purchasing equities. Money managers devote abundant time to these decisions, as we would expect them to. And they do well, it seems.

So what’s the problem?

They devoted almost zero research to the decision on the flip side – when to sell. The researchers found that most money managers didn’t apply anywhere close to the amount of rigorous research on selling as they spent on their buying decisions.

As a result, they sold winners too early, missing out on future gains. Kind of like selling Netflix in 2013. And they also gave up on poor-performing equities too soon, missing out on hugely profitable turnarounds.

In other words, they violated a core tenet of investing, which is driven more by emotion and instinct rather than research and data. That core tenet is: Past performance is no guarantee of future results. By looking at the past performance of their best and worst-performing buys, they used that information – even though it’s mostly meaningless – as their primary decision on when to sell.

In fact, the failure to beat the market at the ‘sell’ step in the process was so severe that, according to the study, by simply randomly picking stocks to sell, you would have done better than these money managers did.

Having no strategy at all in determining when to sell, you would have beaten these seasoned professionals.

Amazed? Shocked? Dismayed?

How does that make you feel? What should you do in response?

What to Do with Your Money Based on the Research

Remember, this study looked at some of the biggest money managers in the world in terms of assets under their control. And these managers failed to beat the market because they didn’t research their decisions to sell.

As a high net worth individual looking for the right wealth manager, you have three main responses to choose from:

1. Stick with money managers and hope they figure it out

2. Shout this research from the rooftops and try to change the industry so more managers will apply the same level of rigor to their selling decisions as they do their buying ones

The chances of the investment industry changing in this regard are low, at best. And widespread change of this sort takes decades. You don’t have time to wait for the industry to figure this out.

You need a different approach to wealth management. One based on a different model of financial planning.

See the 8 critical components of any high net worth financial plan [link to blog 13]

Successful financial planning requires more than just entrusting your wealth to money managers. In other words, picking and choosing funds from various big investment firms all by yourself isn’t the approach that will assure you of an anxiety-free and secure retirement.

But it also requires more than just hiring a random financial advisor who might appear to know the “better” funds to invest in. What performs well one year performs poorly the next. Why? Because past performance has no bearing on future results.

In other words, if your advisor operates within the same system of buying and selling and trying to beat the market, they will fail to earn you the investment performance and financial peace of mind you seek, at the level of assurance you seek it.

The Question to Ask Your Prospective Financial Advisor:

How can you help me feel secure that my money won’t run out?

For the answer you’re looking for, and 9 more questions to ask before this one, read this article.

For the most comprehensive help possible in choosing the best financial advisor for you as a high net worth individual, get our free Ultimate Guide by clicking the image below. For the ultra-high net worth version – click here.